The present invention generally concerns techniques for determining one or a range of fair values prices for equity research.
Traditionally, there are two types of arrangements whereby an institutional investor, such as a pension fund, a mutual fund, a hedge fund, etc., pays for equity research. First, in typical bundled brokerage arrangements, a sell-side firm (such as a brokerage or investment house) provides a fund manager for an institutional investor with a package of services, including trade execution and equity research, for a single price. Second, in typical soft commission arrangements, the sell-side firm agrees to pay for certain goods and services (e.g., research) that are supplied to the institutional investor (usually by a third party rather than the sell-side firm) in return for which the institutional investor agrees to direct a certain level of business (order flow) to the sell-side firm.
In 2001, Mr. Paul Myner issued his report on institutional investing in the United Kingdom (the “Myner's Report”). Among other things, the Myner's Report recommended ending such bundled and soft commission arrangements. Among the reasons cited was lack of transparency; bundled brokerage and soft commission arrangements make it difficult for fund investors to tell how much they are paying for individual services. The Myner's Report concluded that there was an incentive for fund managers to direct business to brokers to obtain additional services, rather than the most favorable trade execution terms for fund investors, and that this represented an unacceptable market distortion.
In response to the Myner's Report, the Financial Services Authority (“FSA”) of the U.K. issued Consultation Paper 176 (“FSA 176”). FSA 176 proposes, among other things, a prohibition on fund managers passing through the cost of sell-side services (other than execution costs) to their customers.
Although bundled brokerage arrangements are not currently prohibited in the U.S., alternative mechanisms to price equity research are presented below.